Mexican assets sell-off as Sheinbaum wins Presidency by large margin

Claudia Sheinbaum was elected President of Mexico with close to 60% of the votes. Xochitl Galvez Ruiz and Jorge Alvarez Maynez gained only 28% and 10% of the votes respectively. Although the result was anticipated by polls ahead of the election, it was surprising that Sheinbaum’s incumbent MORENA party achieved a ‘qualified majority’ in the Deputies, and it is close to securing one in the Senate. A qualified majority is achieved when a party gains two thirds of the total seats in the house, which is the margin required to approve constitutional reforms.¹

Investors fear a weakened opposition in Congress could drive the incoming administration to drastically change the country’s constitution and the way economic policy is implemented. This triggered a sell-off in the Mexican IPC equity index of over 6% after the election and a depreciation of almost 4% of the Mexican peso against the US dollar, see Chart 1.

Chart 1. Mexican assets sold off as MORENA secures a large majority in Congress.

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 04 June 2024.

In a speech following the announcement of the election result, Sheinbaum sought to calm markets by commenting that she is committed to fiscal discipline and to preserving the independence of the Central Bank of Mexico. She also pledged to promote private investment and respect businesses. As the new President, Sheinbaum faces three main challenges ahead:

(1) Maintain fiscal discipline
One of Sheinbaum’s first decisions on the day after the election was to maintain Rogelio Ramirez de la O as finance minister. This was intended to show a continuation with Lopez Obrador’s (AMLO) economic policies and a commitment to fiscal caution. Although AMLO’s last budget included a large fiscal stimulus, equivalent to 2.4% of GDP, the overall fiscal management has been prudent during his term, see Chart 2. According to IMF estimates, Mexico’s fiscal deficit is expected to rise in 2024 to 5.9% of GDP. Investors view this as a one-off event since AMLO had pledged to finalise some of the infrastructure projects started during his Presidency. Finance minister Ramirez de la O pledged to halve the fiscal deficit, but this might be difficult to achieve with GDP growth expected to fall below 2% in 2025 and 2026. ²

Chart 2. General Government's fiscal balance (% of GDP)

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 04 June 2024.

(2) Deal with rising violence from drug cartels
This was one of the top priorities for voters during the campaign. AMLO’s legacy on this issue has been mixed, with a rising number of murders related to conflicts between drug cartels. External analysts accuse the government of under-reporting the number of deaths and kidnaps associated with drug cartels across the country.

Sheinbaum, a former mayor of the capital Mexico City, has experience with dealing with rising violence. However, it remains to be seen whether strengthening the power of a military-run federal policy force, as she proposes, will help reduce gang violence. Rising violence has been seen as a concern by prospective investors and has played a key role on the decision of people to migrate to the US through the north border. In 2023 nearly 2.5 million people tried to cross the US-Mexico border irregularly.³

(3) Seek good relations with the next US President
Mexico has been one of the main beneficiaries from the US nearshoring of industrial production. After more than two decades, US imports from Mexico exceed those from China as a percentage of GDP, see Chart 3. However, if Donald Trump were to win the US election in November, he could try to renegotiate or abandon the USMCA trade agreement, in place since 2018, due to increased Chinese investment in Mexico that aims to benefit from its access to the US market.

Although AMLO succeeded to have a working relation between Mexico and both the Trump and Bided Administrations, it remains to be seen whether Sheinbaum can do the same. The trade war between US and China provides Mexico with an opportunity to attract investment and create jobs.

However, the task will not be easy and Sheinbaum will need some structural reforms to tackle corruption and crime, encourage more competition in the economy and reassure investors they can benefit from the US nearshoring efforts.

Chart 3. US imports from China and Mexico (% of GDP)

Source: LSEG Data & Analytics, IMF and EFGAM. Data as at 12 April 2024.

The fact that her party has achieved a large majority in Congress poses risks to investors. Sheinbaum’s intention to pursue a disruptive reform of the judicial system is likely to create headline risks to Mexican assets in the coming months. Her plan is for members of the Supreme Court to be elected by the people, rather than being appointed based on merit.

In addition, it remains to be seen whether she will pursue any of AMLO’s previously proposed constitutional reforms of the energy sector, the electoral system and domestic security. A qualified majority would enable Sheinbaum to achieve this, although it could undermine investor confidence. For the time being, it seems likely that Mexican assets will remain volatile for the next few weeks, as markets will seek more clarity on the type of Presidency they should expect from her.

¹https://go.pardot.com/e/931253/forms20by20the20party20itself-/46r27/378960156/h/491vk17C9S6iIKN-obW3FHvsMN4zvjbnXXGq7HM4pB4
² IMF World Economic Outlook, April 2024.
³ The Wilson Center, January 2024.